By Robert Schermerhorn, CFP
With only 14 percent of small employers with fewer than 100 employees sponsoring a retirement plan according to the Government Accountability Office, finding the right retirement plan is more important than ever. Having a retirement plan in place not only helps the business owner work towards securing their financial future, but can also make your business more competitive in attracting, and maintaining, top employees.
There are also potential tax benefits to offering a plan that reduces your company’s tax burden, as plan contributions are deductible as a business expense, as well as tax credits for new start-up plans.
Although most business owners think of a 401(k) plan when deciding on a retirement plan, there are several different types of plans available that may be more appropriate for your business.
The following are retirement plans that small business owners might consider:
1. 401(k) plans
2. Solo 401(k) plans
3. SEP IRA (Simplified Employee Pension Plan)
4. SIMPLE IRA (Savings Incentive Match Plan for Employees)
Each of these retirement plans has different features, such as who contributes to the plan, contribution limits, plan administration, and vesting schedules (which is the right to reclaim contributions if an employee leaves the company before a set time), among many more. In order to determine which plan is right for your business, there are several key questions to ask: Do you have, or plan to have, any employees?
Do you want your employees to be able to contribute? How much does the business want to contribute? How much is the business able to contribute? Do you have high employee turnover? What is the main priority of the plan- maximize contributions or simple plan administration?
401(k) plans offer more choices in plan design, such as optional employer contributions, varying vesting schedules, employee eligibility, Roth contribution options, etc. For 2017, employees can contribute up to $18,000, or $24,000 for those over age 50. If employer contributions are elected, the combined contributions (both employee & employer) cannot exceed $54,000. Multi-year vesting schedules are also available, making it an attractive option for businesses with high employee turn-over. For example, a five year vesting schedule would grant 20 percent ownership of employer contributions each year, until 100 percent ownership is reached after five years. You can also elect immediate vesting. Although plan flexibility is great, 401(k) plans require annual plan filings as well as special IRS testing to ensure the plan does not favor highly compensated employees. Due to complex plan administration requirements and potential costs, 401(k) plans may be more appropriate for larger firms.
Solo 401(k)s are for self-employed individuals or business owners with no employees other than a spouse, and no plans to add employees. This plan offers the largest possible contributions, since the business owner is acting as the employee as well as the employer, allowing for maximum employee contributions, including a catch-up contribution for those over age 50, and maximum profit sharing contributions, up to the limit of $60,000 for 2017. Although this plan offers immediate vesting, there are annual plan filings that must be fulfilled if assets exceed $250,000. Because of the high contribution limit and reduced plan administration requirements, this is a great option for businesses without employees (and know that they will not be adding any employees in the near future).
SEP IRAs are 100 percent funded by the employer (no employee contributions are allowed), have similar contribution limits to 401(k)s, offer immediate vesting, are very easy to establish, and have very little plan administration required. For 2017, the employer can contribute up to 25 percent of employee’s compensation, up to a maximum of $54,000. Annual employer contributions are not required and are at the employer’s discretion each year. In years where a contribution is made, the same percentage must be contributed to all employee accounts, including yours!
SIMPLE IRAs allow for employee contributions and a mandatory employer match, although the contribution limits are less than for a 401(k). In 2017, employees can contribute up to $12,500, or $15,500 for those over age 50. Employers can choose between 2 contribution formulas.
The first formula matches employee contributions dollar for dollar up to 3 percent of their compensation. The second formula is where employers contribute a flat 2 percent of each eligible employee’s compensation, regardless of employee contributions. Companies must have less than 100 employees. This plan offers immediate vesting, is also easy to establish (although require advance employee notifications), and has little plan administration.
Regardless of which retirement plan is utilized, the new start-up plan tax credit is available to businesses that establish a new SEP, SIMPLE IRA, or 401(k) plan, subject to specific qualifications. The tax credit is 50 percent of the “ordinary and necessary expenses” associated with establishing or administering an eligible plan for the first 3 years of plan operation with up to a maximum of $500 per year. Utilizing this seldom-used federal tax credit prevents money from being left on the table!
Small business owners tend to focus exclusively on their business, consumed with the day to day operations and identifying ways to grow, but sometimes fail to focus on themselves and their own financial future. The various retirement plans available to small business owners allow you to maximize your tax deductions, attract, retain and provide for your top employees, and allow you to work toward securing the financial future that you’ve worked so hard to achieve.
Schmerhorn is a certified financial planner at Saratoga Financial Services.